Heavy-tailed distributions and robustness in economics and finance (Q2350232)

Diversification advantage means that the capital invested in several assets has a smaller risk than the same capital invested in a single asset. While this phenomenon is the case for normally distributed asset returns, the diversification advantages may not exist or even turn into disadvantages in case of heavy-tailed distributions. The importance of heavy-tailed laws in finance and insurance is well known and also is confirmed in the last chapter of this book that discusses robust inference and presents case studies. The first two chapters are devoted to the analysis of diversification benefits in terms of the Value-at-Risk, which is a commonly used risk measure based on the quantile of the distribution for the positive linear combination of assets. On the theoretical side, the authors discuss diversification effects for distributions that arise as convolution of symmetric stable laws with index \(\alpha\in(0,1)\), another family consists of convolutions of such laws with \(\alpha\in(1,2]\), and the third family consists of log-concave distributions. Also convolutions of members of the first two families with the last one are considered. The obtained results are illustrated using a number of applied problems from insurance, reinsurance, risk pooling and sharing, and growth models. It is shown that some situations may lead to diversification traps and diversification disasters depending on the degree of heavy tailedness. The inference part concentrates on recently developed robust approaches. The book is a useful summary of various results from the literature concerning heavy-tailed distributions in economics and finance with emphasis on applications.